INVESTORS continue to snap up sub-Saharan African sovereign debt, attracted in part by yields unavailable elsewhere. But will rising risks in the region cause investors to re-assess their risk appetite, with potentially negative consequences for those countries that have tapped the euro bond market so successfully during the past few years?
Debt levels in many African countries are on the rise again, as they invest in infrastructure and other developments, but it is not so long since many of these had significant debt write-offs arranged under the International Monetary Fund and World Bank’s heavily indebted poor countries initiative.
Strong economic growth across most African countries has not yet led to stronger credit quality, partly because fiscal and external positions have continued to weaken and debt levels are rising. The fact remains that gross domestic product (GDP) per capita ratios for many African countries are among the lowest in the world, often only between $1 000 (R11 038) and $2 000.
Faster growth has caused higher demand for consumer and capital goods imports, which has put pressure on these countries’ current account balances. It has also increased demand for infrastructure and social spending, which has led to sizable fiscal deficits in many sovereigns.
Twin deficits have increased funding requirements at the time when donor support and concessional lending to Africa have decreased. Previously low-income countries have attained middle-income status, making them ineligible for grant aid, and in other cases donor countries have cut back on aid due to concerns about governance in the recipient countries, or because of their own budgetary pressures. This has meant African sovereigns have had to find other funding sources, namely non-concessional borrowing, such as euro bonds.
Sub-Saharan African sovereigns see euro bond issuance as a means of diversifying sources of finance (away from traditional multilateral and bilateral loans), as well as aiding sovereigns’ integration with the global financial markets, particularly as potential frontier investment destinations.
Moreover, domestic government debt markets are often shallow and provide less attractive funding conditions than euro bonds which help not only to fund fiscal deficits but shore up foreign currency reserves at the same time.
Debt
We project that the sub-Saharan African sovereigns we rate will borrow an equivalent of $61 billion from long-term domestic or global commercial sources this year, a 49 percent increase in long-term commercial debt issuance compared with last year. About 26 percent, or $16bn of the sovereigns’ total gross borrowing, will be to refinance maturing long-term debt, with Nigeria and Ghana facing the highest debt roll-over ratios (including short-term debt).
African government debt has increased during the past few years, although strong nominal GDP growth rates have sometimes helped to mitigate or even offset the effect on debt-to-GDP ratios. Nevertheless, some African governments have debt ratios that have increased substantially after the debt relief received in the mid-2000s.
Against this backdrop of rising debt and large current account deficits, commodity price shocks remain key risks for countries that rely on commodity extraction and exports. For example, a significant and prolonged fall in the oil price would impact economic growth and fiscal revenues of the big oil producers. If investors reappraise their risk appetite and demand higher yields from African sovereigns for buying their bonds, this could create funding challenges further down the road for these countries.
While we see many countries in Africa on a strong growth path with improved political accountability, the downsides of investment and growth are – at least temporarily – fiscal and external imbalances. The challenge is to create enough growth to eventually counteract these imbalances.
African sovereign issuers have enjoyed record low borrowing rates, with market conditions being such that lowly rated sovereigns can get access. But in our view this trend partly reflects a bullish market hunting for yield during a period of super-low interest rates in developed countries, rather than an improvement in fundamental creditworthiness on the continent.
Konrad Reuss is managing director and South Africa office head at Standard & Poor’s.